Treaty Based Tax Return for UK

[freshy70]

Filing a 1040NR for a UK resident. Business profits are exempt from taxation because he doesn't have a permanent establishment in the U.S. per Article 7 of the treaty. I get 2 critical diagnostics 1) "For efile purposes, if Schedule OI, Line L, Income Exempt From Tax contains the tax treaty article '7' for United Kingdom then the corresponding exempt income must not be greater than the sum of gross income on all Forms 1042-S containing an income code of '17' plus the sum of all box 1 wages from all Forms W-2." This doesn't make sense because there is no income reported on 1042-S and not tax was withheld from his profits. 2) "At least one of the following fields must be present on an e-file return: total Income, adjusted gross income, tax on income, total credits, total tax or total payments." So do I need to paper file this return since there are none of these items present? The return is simply to report income tax is exempt by treaty.

[itonewbie]

---

@freshy70 wrote:
This doesn't make sense because there is no income reported on 1042-S and not tax was withheld from his profits.

---

Why doesn't it make sense?  The fact that you are preparing the return to claim treaty exemption on the income is exactly because your client had US-ECI, most likely by virtue of having been present in the US conducting business (albeit without a PE).

Question is whether your client's business activities in the US were conducted in the capacity of an employee of his/her foreign entity or as an independent contractor.  Since you are invoking Article 7, the presumption is that it is an independent contractor because Article 14 would otherwise be triggered instead.

The service provider, whether an entity or an individual, is required by law to furnish a certificate of foreign status (W8-BEN-E or W8-ECI) to the payor, as the withholding agent, in order to establish the withholding requirements or eligibility for treaty exemption.  The withholding agent, in turn, is legally required to withhold (where applicable), remit, and report by issuing 1042 and 1042-S.  This is analogous to how the process works for 1099 and W-2; penalties are levied similarly for failure to fulfill these fiduciary duties.  The 1042-S is your client's equivalence of a W-2.  It makes perfect sense - there is nothing special about it.

In the event 1042-S was not issued, your client would still be required to report the ECI on the US return and, in order to claim claim treaty exemption, make the necessary disclosures on the return as you are doing now.  Without a 1042-S reporting the corresponding amount being claimed for treaty exemption, the return has failed rules that the IRS has set up to validate these returns.  It does look like the return will need to be filed on paper.  Your client would be well-advised to ensure the proper process is followed going forward to avoid unnecessary complications.

[freshy70]

Thank you for your response. I new I could count on you more than support.

"because your client had US-ECI, most likely by virtue of having been present in the US conducting business (albeit without a PE)" No presence in the U.S. He sells retail products through a fulfillment partner.

Business was conducted as foreign-owned U.S. LLC. Therefore no W8-BEN-E or W8-ECI is issued because business is conducted with a U.S. LLC with an EIN. A 1099-K was issued to the EIN that the LLC uses.

Help me Obi-Wan Kenobi, you are my only hope.

[itonewbie]

"Business was conducted as foreign-owned U.S. LLC."

Then why is there no PE in the US?

[freshy70]

For these reasons there is no PE:

4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

The 3rd party he uses in the U.S. is simply to store and deliver goods. He has no control over that enterprise nor is it part of his company.

[itonewbie]

[Edit: Will come back with a fuller response]

[itonewbie]

Could you lay out how the businesses in the US and UK are structured, in terms of entity types and relationship down to the individual taxpayer level?  We already established that the US entity is an LLC but we don't know what's upstream.

Also, which is the resident state of this US LLC?

[freshy70]

Upstream is an individual UK resident person. The U.S. LLC is registered in DE.

[itonewbie]

Good to know.  If there's another entity between your client as an individual and the US LLC, the outcome could be different.

In that case, your client will likely need to file the return on paper but make sure the proper process is followed going forward.

Note, however, states generally do not recognize income tax treaties although a few do have clearly stated positions.  You should review whether your client's income would be subject to state income tax if you have not already done so.

Hope this helps.

[itonewbie]

---

@freshy70 wrote:

For these reasons there is no PE:

4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

The 3rd party he uses in the U.S. is simply to store and deliver goods. He has no control over that enterprise nor is it part of his company.

---

Btw, I should have asked a couple other questions about these goods that are stored and delivered in the US.  Where are these manufactured?  How are the sales negotiated, contracted, and settled?

[freshy70]

The goods are manufactured all over the place. All he does is buys goods online from U.S. retailers and resells them for a profit. It's arbitrage. Sales are direct to consumer through Amazon.com

[itonewbie]

That changes nothing then.

Are you also filing F.5472 with proforma F.1120?

[freshy70]

I have been for other clients and intended to for this one. I have other clients who own U.S. LLCs and have no income so I've only been filing 5472 with 1120. For another client I also did the 1040 NR with 8833 and Schedule OI to claim treaty exemption but they needed an ITIN so I mailed all of that along with W-7 and the ITIN was granted. Since this customer already has an ITIN, I was trying to file electronically and ran into this issue. I prefer to e-file rather than mail so I can get the e-filing confirmation.